Fix and flip investment as a real estate professional

[usernamesarehard]

I bought 2 homes. One home is my primary and a duplex. I rent half and claim half the deductions as a rental business. I also claimed loses on it for extensive renovations on the rented side. On the other home, I purchased and held for a year. The income accrued off it was less than the losses made on the duplex. Thus I owe no taxes for that tax year. I am assuming I can still claim the 500k credit for a married couple on the duplex since it is my primary residence. Is this correct? This is spread out over multiple years fyi. ie 5 years

[leeloo]

What credit are you referring to? The 500k exclusion for selling your primary home? You can get that if you meet the requirements upon the sale but only through the personal half. The duplex is business property and the other house is not your primary residence and it is unclear if it is also a rental.

https://www.irs.gov/taxtopics/tc701

[Hal_Al]

@usernamesarehard  said "I also claimed loses on it for extensive renovations on the rented side."

"Extensive renovations"  cannot be deducted. Te cost must be capitalized and depreciated (deducted) over 27.5 years. The undepreciated part may be added to you coat basis, upon sale, resulting in a reduced caopital gain or even a capital loss. 

Q.  I am assuming I can still claim the 500k credit for a married couple on the duplex since it is my primary residence. Is this correct?

A. No.  When you sell the duplex, you may exclude the capital gain (up to $500K) only on the half that was your principal residence (assuming you owned  and lived in it 2+ years). 

@usernamesarehard  said "This is spread out over multiple years fyi. ie 5 years".

I don't know what that means. The exclusion of the gain on the sale of  your principal residence is claimed in the year of sale. 

[usernamesarehard]

Thanks for the reply! I thought if I did the remodeling before I rented it out, it counts as a deduction. Is this correct? Is there ever a scenario that when you remodel an investment that it counts as a deduction? I thought when you purchased an investment property then remodeled it it counted as a deduction. i.e. bought for 100k paid for 50k remodeling sold for 200k. taxable income 50k? is it not the same when you purchase a rental?

[usernamesarehard]

Also I'm assuming that if I were to reduce the percent used as a rental to 10% for the last 2 years, 90 % would qualify for the 500k and the 10% would be capital gains.

[usernamesarehard]

ignore half of this I just realized you answered it. but still curious about:

I thought if I did the remodeling before I rented it out, it counts as a deduction. Is this correct? Is there ever a scenario that when you remodel an investment that it counts as a deduction?

[Hal_Al]

Q. I thought if I did the remodeling before I rented it out, it counts as a deduction. Is this correct?

A.  No.

The remodel cost is added to your cost basis. In the case of the rental portion, that cost is depreciated over 27.5 years.  Even "repairs" done, before renting it out, must be capitalized.

Q. Is there ever a scenario that when you remodel an investment that it counts as a deduction?

A. Simple answer: No. Small remodels done, after it is rented out, may qualify for the "safe harbor" deduction up to $2500. See https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations

But, the increased cost basis reduces the amount of your capital gain, when you eventually sell. 

[usernamesarehard]

Thanks for the clarity! I just have one more question that has been bugging me. Do I have to show some sort of proof for the cost basis?

How does the IRS know that I'm not making it up? I don't want to trigger an audit because isn't the purchase price reported to the IRS when I sell the home? Is there another form or something to show where the difference is coming from? 

[Hal_Al · Accepted solution]

Q.  Do I have to show some sort of proof for the cost basis?

A. No, not at the time you file your tax return.  That comes later, if at all, if you are "audited". 

Q. How does the IRS know that I'm not making it up?

A, They don't.  If they suspect, they'll ask.  Don't try to attach proof; it'll foul up your e-fing and will,most liekly, be ignored. 

Q. Is there another form or something to show where the difference is coming from? 

A. Usually not.  Several years ago, the IRS implemented changes to the form 1099-B to make stock brokers report cost basis/capital gains for most stock and mutual fund sales.  But, that has not yet happened for real estate sales. 

[usernamesarehard]

So just to add clarity incase anyone ever digs this up. You can as a real estate professional use the losses from one home as a deduction for another home. I did just realize though that renovations do not count as a deduction but are added to the cost basis to the home when it is sold or if you decide to depreciate it over 27.5 years. There is also no issue with the 500k deduction for married couples selling their primary home as long as you are not listing either side of the duplex as a rental on your tax returns. Also you apparently do not need a justification for the cost basis for your investment sale if it is a fix and flip.(held for 2 years)

Please let me know if I'm wrong.